Gross Gives Up Keys To PIMCO Mercedes and Today’s Other Top Stories

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Today the Financial Times has a fascinating article on the inner workings at PIMCO. Not the infamous management style of Gross, which has been the subject of numerous articles of late. But a look at the clever trading strategies Gross and his team use to maximize returns, even in the most demanding markets.

Gross revealed his strategy to an audience of wide eyed financial advisers in Chicago. “I’ll be handing you the keys to the PIMCO Mercedes,” he told them.

Gross went on to say, that unlike smaller fixed income funds that might just buy and sell bonds, the $230bn PIMCO Total Return fund uses a clever user of derivatives trading strategies, Mr Gross went on to explain, PIMCO is one of the biggest sellers of insurance against market volatility.

“Sounds dangerous and is sometimes,” Gross said. “Obviously, the volatility has to be underwritten properly and priced appropriately. It doesn’t pay to write flood insurance before a flood, but over time it has been a very respectable structural template alpha generator.”

So how do does PIMCO underwrite market volatility? The FT says: Selling volatility or ‘vol’ as the traders call it, typically involves selling options, which would pay out if a particular market moved by more than a pre-agreed amount. The Vix index, sometimes referred to as the stock market’s “fear gauge”, is based on the price of a combination of options on the S&P 500. The more investors are paying to protect themselves from big swings, the higher it goes. The fixed income market has a similar gauge called the Move index.

The attraction of selling vol is that, over several decades, payouts have been less than the money investors have taken in through premiums. The volatility implied by the price of options has never been fully realised in the actual, subsequent movement of the stock or bond markets.

“If there is a flare up that causes volatility to jump, you will have a scramble at that point as sellers will need to buy it back,” says Mr Tai.

Mr Gross told his audience that such flare-ups can lead to bouts of underperformance for his fund, but it is a short-term price worth paying.

Todays Other Top Stories

Municipal Bonds

Morningstar: – Muni market mid-year update.– The municipal bond market faced a rather tough year in 2013, with news of troubles in Detroit, Puerto Rico and elsewhere scaring off some investors. This year hasn’t exactly been smooth sailing for the muni market either, but the waters seem a bit calmer.

Cate Long: – Puerto Rico ring fences its public corporation debt.– In a dazzling effort, Puerto Rico Governor Alejandro Garcia Padilla presented legislation to restructure the debt of several public corporations. Both the Puerto Rico Senate and House approved the measure and pushed it to conference where statutes require that it be reconciled by the end of the legislative session on June 30. Seldom have financial markets seen such an elegantly choreographed approach to haircutting sovereign debt.

Investment Grade Bonds

News on Invest: – Banks create corporate bond trading hub.– Banks including Goldman Sachs and JPMorgan Chase are creating a new trading platform for US corporate bonds as they seek to maintain their hold on the business of trading US companies’ debt while boosting liquidity in the $10tn market.

High Yield Bonds

Market Realist: – Why are junk bond yields the lowest ever on record? – Returns on high-yield debt correlate more to stock market returns rather than the returns on other forms of debt, as spreads between investment-grade and non-investment grade bonds usually decline due the belief that high-yield debt would have improved debt servicing ability in an economic expansion.

USA Today: – Investing: Time to sell your junk.– In finance, as in life, disaster doesn’t always strike suddenly. There are usually warnings beforehand. And while predicting markets is dangerous, there really are very few happy outcomes from junk bond funds right now.

Forbes: – High yield bond funds back to positive with $619M investor cash inflow– Retail-cash inflows for high-yield funds totaled $619 million in the week ended June 25, according to Lipper. It’s a reversal that completely erases last week’s $239 million outflow and it represents the seventh inflow in the past eight weeks, for a combined $2.8 billion inflow over that span.

Emerging Markets

Businessweek: – Emerging markets show biggest premium since ’12 with ETFs.– Investors are returning to developing-nation ETFs after pulling $31 billion from them in the year through March on concern that the end of easy-money policies from central banks and flare-ups of violence from Thailand to Ukraine would destabilize markets.

Streetauthority: – The next bull market in bonds starts now.– Unfortunately the opportunity in U.S. debt has long since evaporated. The Federal Reserve has used its printing press to push prices to all time highs. Buying bonds now would be suicide. They simply have nowhere to go but down. But it’s a different story in emerging markets. In fact, right now these countries could be setting up the biggest bond trade since 1982. And like back then, conditions are ripe for incredible returns.

New Focus Financial: – Is the reversal in emerging markets sustainable? – Investors fled from developing markets around this time last year. In June 2013, $32.5 billion was pulled out of the stocks and bonds of 30 emerging markets, according to the Institute of International Finance Inc. However, since the trough in June of last year, investment flows have reversed. Question is, can the run be sustained.

Businessweek: – Argentina bond judge says he will nullify BNY payment.– Bank of New York Mellon Corp. must return a $539 million deposit from Argentina intended for restructured bondholders, a U.S. judge ruled, calling the transfer an “explosive action” that disrupted potential settlement talks with holders of defaulted debt.

Catastrophe Bonds

Investment Strategy

Kiplinger: – Great funds to own in retirement. – A smart way to assemble any investment portfolio, including a retirement portfolio, is to put your money in low-cost, no-load mutual funds. Here are a few funds that can help you meet your retirement goals (all returns are through June 25).

Bond Funds

ETF.com: – 10 Top-performing ETFs in first half of 2014.– Treasury bond ETFs may have dominated the headlines in the first half of the year with a performance that few anticipated as yields dropped. But it was commodities, gold miner and international equity funds linked to India that stood out with outsized returns in the first six months of the year.